S&P Global (SPGI, Financial) is a leading financial information provider with several moats. It has been a rock-solid investment for financial investors over the years due to the growth of the U.S. equity and debt markets. The company operates through four business segments: Ratings, Market Intelligence, Platts and Indices. Its market leadership in an oligopolistic ratings market, combined with a highly robust market intelligence business and strong margins and cash flows, are responsible for the company’s sky-high valuation.
S&P Global has been in the news over the past few months because of its intended merger with IHS Markit (INFO, Financial), which will be one of the largest mergers in the financial services industry in recent times. The company has an incumbent position in highly sticky businesses with favorable macro trends, as does the company it intends to acquire. Given the upside potential for these businesses, is S&P Global's stock still a buy despite the high price tag?
Recent financial performance
S&P Global recently reported strong financial results and another all-around beat. The company’s revenue of $2.11 billion for the quarter ended June 30 grew 8.39% compared to the corresponding quarter of 2020. The company beat the analyst consensus estimate of $1.99 billion.
These revenues translated into a gross margin of 74.69% and an operating margin of 57.83%, which were higher than that in the same quarter of last year.
S&P Global reported net income of $798 million and adjusted earnings per share (EPS) of $3.62, which outperformed the average Wall Street expectation of $3.27.
The company had robust cash generation. It reported $923 million in the form of operating cash flows and spent $9 million in investing activities during the quarter.
Strong ratings and market intelligence businesses
S&P Global’s Ratings business has benefited from the enduring tailwind of low interest rates. Falling interest rates have alllowed companies as well as the government to issue record amounts of new debt. This creates a huge demand for S&P Global’s Ratings products. The company, together with Moody’s (MCO, Financial) and Fitch, is a part of the three leading U.S.-based rating agencies. S&P Global’s position is dominant among the three, with a market share consistently around the 80% mark in the U.S. and well over 50% across the rest of the world.
The company is driven by institutional investor guidelines and charters that often require investment-grade ratings by at least two of the three of the leading rating agencies. Most clients typically obtain ratings on the same debt and this rating provides a uniform standard to buy-side investors in order to discriminate and rank debt established on specific criteria.
Despite the controversies associated with the company during the 2008 financial crisis, S&P Global remains a trusted name for the buy-side as well as companies looking to issue debt. With the increasing debt issuances, the demand for S&P’s Ratings business is expected to remain rock-solid.
The company’s Market Intelligence business is also a solid arm with a high level of foreseeability that inspires investor confidence. It is worth highlighting that about 97% of revenues of this arm are recurring in nature and it is witnessing an annualized growth rate in the mid to high-single-digits. S&P Global has a strong industrial position and serves a wide variety of clientele ranging from banks and insurance agencies to large corporations, private equity funds, academic institutions and more.
Its S&P Capital IQ platform is one of the leading financial platforms in the world, competing with the likes of Bloomberg, Thomson Eikon and FactSet (FDS, Financial). The company has a strong ESG offering and has the ability to not only increase revenues through higher prices but also through upselling various offerings to its Market Intelligence customers. The management expects this business to grow by around 7% this year.
Merger with IHS Markit
S&P Global and IHS Markit have announced an agreement to merge in an all-stock transaction valuing IHS Markit at $44 billion. The companies are in the process of regulatory approvals and recently announced an agreement to sell IHS Markit’s oil price information services, coal, metals and mining and PetroChem Wire businesses to News Corp (NWSA, Financial) for $1.15 billion in an all-cash deal. The divestment must be carried out to avoid anti-trust issues.
IHS Markit should benefit the S&P Global platform by increasing its data, analytics and client relationships. The merger is meant to strategically double S&P Global’s ESG business and provide entry into fixed income indicators. The management estimates cost synergies of $480 million and revenue synergies of 8%, given the complementary assets of IHS Markit and S&P Global.
The transaction is expected to close by the second half of 2021.
As we can see in the above chart, S&P Global’s stock has had an impressive runup as a result of its good results as well as the merger announcement. However, large mergers come with extensive integration risks along with the risk of not hitting synergy targets. Its rating and index pricing power may possibly drive customers to seek alternatives. I believe the company’s current valuation of 100.6 times book value and its price-earnings ratio of 42.42 is too high despite the robust business model and the oligopolistic nature of its market.